The Farm CPA

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

Capital Gains Questions on Selling Farmland

Jul 16, 2013

We had a reader ask the following series of questions. We are going to break them down into a question and answer format.

Q - Regarding capital gain rates and selling farmland - Am I correct to use the difference between a stepped up ( appraisal / time of death ) value of inherited farmland and sale price ( long term )

A - When you inherited land, you will use the basis that the estate placed on the land at the time of death. However, in some cases, this value may be different if the land was originally in a trust for the benefit of the person who died and it did not get included in their estate. As an example, assume Grandpa owned 500 acres of land and passed away in 1970 when the value of the land was $50,000. This property was placed in a trust for the benefit of his only son until his death in 2013 when the land was worth $5 million. Under the terms of the trust, the land is then distributed to the son's children and they elect to sell it for $5 million. Even though it was worth $5 million when the son died, the heirs have to use the $50,000 cost basis since this land was not included in the son's estate.

Q -If so, when I subtract the difference between cost basis and sale price may I deduct broker fees ?

A - All broker's fees, commissions, title insurance and any other related costs of the sale are allowed as a reduction of the gain.

Q - In addition what is the rate I pay as a non resident to the state of Illinois ?

A - For most states, there is no special reduction in the capital gains rates for sale of farmland. Therefore, for most states this income is treated like other income and subject to the same income tax bracket. However, some states, assuming you meet certain specifications allow you to reduce or eliminate the gain from the sale of farmland. You would need to check with your state laws to see if that is applicable in your situation.

Q - Do I pay 15 % cap gain to both the state and the Federal government ?

A - This answer like many income tax questions is "It depends". We previously stated that the state capital gains rate is most likely the same as your other state income tax rate. The federal rate is only 15% up to the threshold amount ($200/$250K), then the extra 3.8% net income income tax kicks in which increases your rate to 18.8%, then certain phase-outs may increase it another 3-6% or more. Finally, if the gain is large enough, the capital gains rate will increase to 20% plus 3.8% plus any related phase-out increases.

Q - Is one deducible from the other ?

A - The state capital gains tax paid is usually deductible on the federal return. However, in many cases, the Alternative Minimum Tax (AMT) will make this deduction have no value assuming the taxpayer ends up in AMT. AMT does not allow a deduction for state income taxes.

Some states allow a deduction for federal tax paid, however, there is usually a limit on the amount of the deduction.

Q - Finally what level of income bracket results ( if any ) in a lower or 0 % cap gain ?

The 0% capital gains tax rete applies to the amount of capital gains that is taxed in the 15% or lower tax bracket. The cut-off for a married couple in 2013 is about $72,000 of taxable income. A taxpayer would calculate all of their other ordinary income after deductions and if this amount is less than $72,000, then the difference would be the maximum amount of capital gains that could be taxed at zero.

For example, assume a couple has ordinary income after all deductions of $30,000. They have a gain from selling farmland of $200,000. $42,000 of the gain would be taxed at zero percent ($72,000-$30,000) and the remainder would be taxed at 15%. However, all of the gain would be subject to their regular state income tax rate (unless they meet certain farmland sale limitations).